Understanding J.C. Penney's Risky New Pricing Strategy

J.C. Penney CEO Ron Johnson recently unveiled ambitious plans to transform the 110-year-old department store chain into a 21st century retail powerhouse. Leveraging his experience at Target and Apple, Johnson aims to create 80 to 100 highly-branded "stores within a store" (e.g. a Martha Stewart boutique). Channeling the spirit of Apple's Genius Bar, every J.C. Penney will also have a "Town Square" offering complimentary services to customers as well as promotions such as free hot dogs and ice cream in July.

The lynchpin of J.C. Penney's revitalization is a new "Fair and Square Every Day" pricing strategy. The plan stems from Johnson's realization that three-quarters of everything sold at J.C. Penney is typically sold at a 50% discount from list price. Instead of using deep discount sales to attract customers, starting this week the chain will simply offer three prices: (1) "Every Day", (2) "Month Long Value" (theme sales such as back-to-school related products in August), and (3) "Best Prices" (clearance). Prices will also now end in "0" instead of "99" and price tags will list just one price (instead of including the de rigueur "previously sold at a higher price" convention).

To be clear, Fair and Square Every Day pricing strategy is different than Wal-Mart's everyday low prices. J.C. Penney's Every Day prices will not be as low as the biggest discounts that it once offered. Instead, its pitch to consumers is why play the "wait for the rock-bottom price" game when Penney offers "pretty good" prices every day?

Quite simply, J.C. Penney lacks the differentiation to make this pricing strategy successful. J.C. Penney's products are fairly homogenous. When selling a relatively undifferentiated product, the only lever to generate higher sales is discounts. Even worse, if competitors drop prices on comparable products, J.C. Penney's hands are tied — it is a sitting duck that can't respond.

Product differentiation is the key to avoiding drastic discounts. Bose and Cartier, for instance, have the differentiation necessary to set a price and stick to it — the price is what it is. Also, the J.C. Penney shopping experience hasn't reached the "loyalty-inspiring" stage, like Nordstrom's, which can immunize it from price competition. Johnson himself has characterized J.C. Penney stores as "tired." It's notable that the Apple Store, which Johnson drove to success and appears to be emulating, has both the product and retail differentiation mojo to successfully implement a Fair and Square Every Day strategy.

Other facets of J.C. Penney's Every Day pricing strategy go against the conventional wisdom about effective pricing. For instance, prices ending in 0 tend to be interpreted as a premium offering, while those ending in 9 convey value. (Entrée prices at upscale restaurants, for instance, typically end in round numbers such as $40 instead of $39.99.) Is J.C. Penney the Wolfgang Puck of retail? Also, for relatively undifferentiated products, a reference price — meaning, the price before discounting — can be helpful to establish value. It's challenging for customers to determine, for instance, whether a run-of-the-mill white dress shirt by Christian Dior is worth $22. However, seeing a "previously sold at $29" blurb on the price tag helps to justify this price psychologically.

Fair and Square pricing is reminiscent of the Value Pricing strategy that American Airlines implemented in 1992. Much like Mr. Johnson's strategy, American sought to rollout a standardized tier strategy (First, unrestricted coach, 14 day advance, 7 day advance) that eliminated rock-bottom discounting. Just as importantly, this strategy was intended to provide confidence to travelers that they were getting a good deal (and didn't have to worry that prices will significantly drop after purchase). So what happened? Rivals responded by offering lower prices and American quickly abandoned Value Pricing.

Once J.C. Penney achieves its long-term retail vision — which is exciting and innovative on many levels — it will have both the product and shopping experience mojo to make its Fair and Square pricing strategy a success. But given its current "I've got something similar" product mix and very price-sensitive customer base, its rollout seems premature.